May 2012, Vol. 239 No. 5


Energy Industry Has Potential As Key Economic Engine

Having proved resilient throughout the Great Recession compared to other sectors, the energy industry has the potential to be a key engine of economic growth and recovery, according to a new study by IHS Cambridge Energy Research Associates (IHS CERA) and the World Economic Forum. The findings of the study were presented at CERAWeek 2012 in Houston.

The report, Energy Vision 2012: Energy for Economic Growth provides a framework for understanding the larger economic role of the energy industry at a time when issues of employment and investment are so critical in a troubled global economy. The report examines the industry’s role as a driver of investment and job creation as well as energy’s importance as the key input for most goods and services in the economy.

“The energy industry is unique in its economic importance,” IHS CERA Chairman Daniel Yergin said. “The energy sector has the potential to be a tremendous economic catalyst and source of innovation in its own right, while it simultaneously produces the very lifeblood that drives the broader economy.”

The energy industry—by nature capital intensive and requiring high levels of investment—has the ability to generate outsize contributions to gross domestic product (GDP) growth, the study says. In the United States, the oil and gas extraction sector grew at a rate of 4.5% in 2011 compared to an overall GDP growth rate of 1.7%.

The highly skilled technical nature of energy industry jobs is reflected in compensation levels. As a result, employees of the energy industry contribute more absolute spending per capita to the economy than the average worker and contribute a larger share of GDP per worker than most industries.

The energy industry’s most important immediate source of economic potential is its high “employment multiplier effect” that is a result of its extensive supply chain and relatively high worker pay. Every direct job created in the oil, natural gas and related industries in the U.S. generates three or more indirect and induced jobs across the economy, the study says. This places oil and gas ahead of the U.S. financial, telecommunications, software and non-residential construction sectors in terms of the additional employment associated with each direct worker.

“We always suspected energy had a vital role to play in the economic recovery,” said Roberto Bocca, Senior Director, Head of Energy Industries, World Economic Forum. “But we were still surprised when the data uncovered the magnitude of the sector’s multiplier effects.”

As the key input for most goods and services in the economy, lower energy prices reduce expenses for consumers and businesses and increase the disposable income available to be spent elsewhere.

Many countries, such as China, India and South Korea, are increasingly focusing on renewable energy sources as potential growth sectors for their economies. Developed countries are also investing in renewables in an effort to meet sustainability goals and emerge at the forefront of this growing sector. However, the higher costs of these technologies create tradeoffs that must be considered, the study says.

“One must look at energy’s contribution to the overall economy, not just its direct contribution,” said Samantha Gross, IHS CERA Director, Integrated Research. “Maximizing direct jobs in the energy sector may not be the right goal if it reduces efficiency and increases energy prices to the detriment of the economy’s overall productivity.” 

Energy Vision 2012 also examines the role of policy in maximizing the economic benefits of energy production and the promotion of steady and reasonable energy prices through stable tax and fiscal schemes and the encouragement of industrial diversification through cluster development. It points to the challenge for resource-rich country to transform oil and gas earning into the foundations of a wider, more diversified economy.

Voser Says Natural Gas, U.S, Oil Improve Global Energy Outlook
Royal Dutch Shell PLC Chief executive Peter Voser told the CERA conference that rising U.S. oil and gas reserves stemming from shale, deep-water and Arctic discoveries are providing a dramatic boost to the stability of the world’s energy supplies.

“These developments promise to dramatically improve the outlook for energy security here and elsewhere around the world,” Voser said, according to prepared remarks. The addition of these resources, especially natural gas from shale, “is already changing global energy dynamics,” Voser said, adding that the amount of oil imported by the Western Hemisphere will fall by up to 50% in this decade.

It is also contributing significantly to U.S. economic recovery, Voser said, by creating jobs, reducing energy costs and boosting critical industries such as chemicals.

The exploitation of unconventional resources, however, faces some challenges, including criticism of hydraulic fracturing operations, which some environmentalists argue contaminate water supplies and generate global warming gases due to methane leakage, according to Dow Jones Newswires.

Voser said that so-called fracking techniques are safe and have been tested for decades, and that when problems have occurred, “they were simply due to poorly designed wells. When a well is designed and constructed correctly, groundwater will not be contaminated.”

Voser backed President Obama’s call for rules to disclose the chemicals used in fracking operations, and said the company in the U.S. already discloses that information on a voluntary basis, “to the extent permitted under our supplier contracts.”

He said the industry needs “to take seriously” the issue of methane leakage in fracking operations. Some studies have “greatly exaggerated” the emissions released in shale production, and ignored steps taken by companies to control these, Voser said, adding that “clearly more research and hard data are needed to understand the true extent of methane releases.”

Worldwide Unconventional Resource Spending Set Record
Fueled by national oil companies and international buyers making acquisitions in North American shale gas, shale oil and tight oil basins, global transactions involving unconventional oil and gas resources reached a record high $75 billion in 2011, according to the IHS Herold 2012 Global Upstream M&A Review. This figure represents 48% of total 2011 worldwide upstream merger and acquisition (M&A) spending.

“Cross-border buyers, led by Asian-based investors, continued to stream into North American unconventional resource plays through asset partnerships and select corporate deals, with a bullish view on potential LNG exports to the Asia-Pacific region in the coming decades,” said Christopher Sheehan, director of energy M&A research at IHS. “In 2011, high crude oil and international gas prices were juxtaposed against persistently depressed North American natural gas prices, leading to a 15-year high in deal counts outside North America.”

Total global upstream M&A transaction value, including corporate mergers, fell 30% from an all-time high in 2010, which was driven by massive asset divestiture programs. Corporate deal value in 2011 rose 19% to more than $58 billion, including BHP Billiton’s $15 billion takeover of unconventional resource-focused Petrohawk Energy, the first upstream corporate merger greater than $10 billion since the ExxonMobil-XTO deal in late 2009.

Sheehan noted the deal flow also increased in all regions outside the U.S. and Canada as international investors pursued the prolific oil discoveries that have occurred in recent years in regions such as deepwater Brazil and Africa. In Australia, the coal seam gas-to-LNG market consolidated further, and evolving markets such as Iraq’s Kurdistan region welcomed new entrants through M&A.

Said Sheehan: “These areas are enticing international investors who continue to face access barriers in established hydrocarbon basins such as Venezuela, Russia and in the Middle East. World-class oil assets continue to be highly sought after by both cash-rich national oil companies and international integrated companies that continue to struggle to materially grow reserves through the drill bit.”

In the international gas markets, growing Asian LNG demand will increasingly fuel merger and acquisition activity from Australia to East Africa. In these regions, Sheehan believes small-cap international E&Ps that own huge resources, but lack sufficient development capital, will increasingly be takeover targets, particularly as the European debt crisis has impacted their access to and the costs of capital.

U.S. transaction value in 2011 reached a 10-year high despite a lower deal count than the prior year, as large joint-venture asset acquisitions by overseas buyers fueled mergers and acquisition activity. The U.S. accounted for approximately 50% of global upstream M&A spending, well above its historical average. Producing oil assets commanded a large deal price premium to gas properties, with a growing focus on liquids potential in emerging basins.

“Established shale gas and emerging shale oil and tight oil plays in the U.S. are attractive to foreign buyers since these plays offer massive discovered resources with low exploration risk in a country with relatively high political and fiscal stability, versus other global regions such as the Middle East, Africa and Latin America. The longer-term potential of LNG exports to the Asia Pacific from Canada and the U.S. is a strategic driver of many of the cross-border shale gas acquisitions in North America,” Sheehan added.

Meanwhile, decade low deal pricing for conventional gas assets, and the upside from liquids-prone plays, attracted increased M&A spending by private equity buyers seeking to benefit from a longer-term North American natural gas price revival.

Continued uncertainty in commodity price direction, wide-ranging geographic oil and gas price spreads, fragile global economic conditions, and limited or higher cost access to capital for many upstream companies are challenging strategic decision making in the industry and causing a consensus gap between potential buyers and sellers.

Added Sheehan: “We believe that, in the present volatile environment, global upstream M&A consolidation will accelerate in 2012 and beyond as the well-financed ‘haves’ prey on the capital-constrained ‘have-nots.’ Many of the latter are key holders of massive undeveloped gas and liquids resources that can provide material growth opportunities or establish a strategic foothold in emerging basins.

“Consolidation, including a rise in corporate takeovers, will be led by national oil companies and sovereign-wealth funds, major integrated companies, global industrial conglomerates, and private-equity investors, who all seek opportunistic purchases of capital-intensive oil and gas assets and financially strained companies that own prolific resource potential.”

Refining Sector Realigns Strategies
Driven in part by continued overcapacity in the global refining sector, refiners realigned their corporate strategies in 2011, with many shedding refining assets and others choosing to exit the sector altogether. This resulted in a very active year for refining transactions, which increased to nearly $6 billion in 2011 from $4 billion in 2010, according to the IHS Herold 2011 Global Downstream M&A Review.

According to the report, transaction values involving refining and other downstream assets, including petrochemical facilities, terminals/storage, propane distribution and diversified downstream assets (refining/terminals/service stations), total global downstream sector transaction values fell to $35 billion in 2011 from $38 billion in 2010. The decrease was driven by a 45% decline in the natural gas distribution subsector, which was offset by significant increases in the propane distribution, retailing/marketing, refining and petrochemical subsectors.
Deal count in the downstream sector rose from 61 transactions in 2010, to 68 transactions in 2011, with refining accounting for 10 deals. Petrochemical transactions actually declined from eight in 2010 to seven in 2011, but the value of those deals rose from a total of nearly $10 billion in 2010 to slightly more than $13 billion in 2011.
The level of transaction value in retailing/marketing subsector in 2011 was about three times the level recorded in 2010, primarily due to Shell’s $1 billion sale of most of its downstream businesses in Africa to Vitol and Helios Investment Partners. The propane distribution subsector was nine times the level of transaction values in 2010, due primarily to Energy Transfer Equity Partners’ exit from the U.S. propane distribution market with its $2.9 billion asset sale to AmeriGas Partners LP.

 “U.S.-based companies, including Murphy Oil, and independent refiner Sunoco, announced their planned exits from the refining sector in 2011, while ConocoPhillips and Marathon Oil elected to de-integrate their respective downstream operations“ said Cynthia Pross, senior analyst for M&A research at IHS and author of the report.

“Faced with the prospect of continued low margins, decreasing fuel demand in the U.S., overcapacity, aging, inflexible facilities, and increasing environmental regulation, integrated oil companies have had to reevaluate their downstream business strategies. For some, the refining business no longer makes economic sense, so they are focusing on their more lucrative upstream operations, which have much better margins due to higher oil prices. For others, it is an opportunity to acquire assets at favorable prices,” she said.
A single transaction, which resulted from an agreement by U.S. refiners Holly and Frontier to merge, totaled $2.7 billion of the total $6 billion refining subsector transaction value. Valero also acquired two refineries in 2011 — Chevron’s Pembroke refinery and other downstream assets in the U.K. for $730 million, and Murphy’s Meraux refinery on the U.S. Gulf Coast, for $325 million.

Refinery location has become a major factor for operators as it relates to crude sourcing logistics, expansion possibilities, environmental pressures and competition, noted Pross. The U.S. East Coast refining industry has been under particular pressure as it faced higher crude oil input costs compared with Mid-Continent counterparts.

Refineries located in more densely populated areas tend to face greater environmental scrutiny, and many of these refineries are older, less complex and less flexible to handle a wide variety of crudes from multiple sources. East Coast refiners rely more on Brent-priced crude than other U.S. refiners and they also face stiff competition from exports from overseas refiners. The recent wide spread between Brent crude prices and West Texas Intermediate (WTI) prices pushed some of these refiners over the edge.

Pross added: “Continued low operating margins and the costs associated with retrofitting older facilities to meet newer environmental standards, make many of these assets uneconomic for some refiners, who’ve chosen to shut the facilities down. In the absence of changes to this market, these refineries may remain shut-in.”

“However, part of the problem in the U.S. is the need for additional pipeline infrastructure to move new crude sources to refining end markets. The ability to transport crude from U.S. shale plays, such as the Bakken crude to the East Coast, for example, would have a significant impact on operating cost dynamics by lessening the cost disparity.” If these dynamics shift enough, refineries that have been shut-in on the U.S. East Coast could possibly become more appealing to potential buyers in the future.

Some buyers have found favorable prices for refining assets. While other companies were shutting down East Coast refineries, PBF, a relatively new refining company, recently restarted the Delaware City, Del. refinery, which it acquired at a favorable price from Valero.

Meanwhile, refiners in other parts of the country have been expanding, such as the Wood River refinery in Illinois. The Shell/Saudi Aramco Motiva refinery in Texas is also expanding. A few years ago, Marathon completed a major expansion and upgrade of its Garyville, LA refinery. Refineries in parts of the U.S. other than the East Coast tend to be larger, more complex and more flexible, and are more linked to petrochemical operations, so they can more easily adjust to market changes and these refineries are also able to source cheaper North American crude.
Several European refineries sold in 2011, after remaining on the market for several months, including ConocoPhillips’ Wilhelmshaven refinery in Germany, which was sold to Dutch firm Hestya, and Chevron’s Pembroke refinery in the U.K., which was sold to Valero, giving Valero its first site in Europe, allowing it to optimize its Atlantic Basin strategy. This was also an opportunity for Asian firms to gain a foothold in Europe at favorable prices, and Shell’s Stanlow refinery in the U.K. was sold to Indian firm Essar Energy, while PetroChina acquired interests in the Grangemouth refinery in Scotland and the Lavera refinery in France. 
Several European refineries have been shut-in and converted to terminals as these refineries have become less economic, struggling with a margin squeeze from overcapacity, falling demand and higher feedstock cost, particularly due to fewer sourcing options with the loss of Libyan crude, which was a severe blow to margins for Atlantic basin refineries. Asian countries, such as China and India, face growing demand for fuels, which could drive Asian companies to look at additional assets elsewhere, including the U.S. and Europe, as potential acquisition targets that could competitively serve those regions.

“We expect refiners to continue to face challenges through 2012 and beyond,” said Pross. “Political tensions in Iran may prove to be a significant factor in the near term, as a result of higher oil prices from reduced supply, which could further erode margins for refiners who are reliant upon crude sourced from Iran, and this could force more refining assets, particularly older units, to go on the market.

“Refiners that have chemical operations will have an advantage because a broader slate of product offerings can cushion against market-demand swings for fuel products, particularly in the U.S., where they can source the growing supply NGLs from shale plays,” she said.

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